MUNI Contract

MUNI Contract

Three and Nine Months Ended September 30, 2005 Compared to the Three and Nine Months Ended September 30, 2004

Three and Nine Months Ended September 30, 2005 Compared to the Three and Nine Months Ended September 30, 2004

Note C - Earnings Per Share

Note D - Stock-Based Compensation

Note E – Marketable Equity Securities

Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis. Marketable equity securities at September 30, 2005, represent common stock of one entity. Management expects that these securities will be sold within one year. An unrealized gain of $334,000 was recorded in other comprehensive income at September 30, 2005.

Note F - Supplemental Balance Sheet and Cash Flow Information

Note H – Secured Borrowing

Note K - Comprehensive Income

Note M - Discontinued Operations

Note O – Dividends

Item 1. - Legal Proceedings

Note C - Earnings Per Share

Note D - Stock-Based Compensation

Note E – Marketable Equity Securities

Note F - Supplemental Balance Sheet and Cash Flow Information

Note G – Revolving Credit Facility

Note H – Secured Borrowing

Note K - Comprehensive Income

Note M - Discontinued Operations

Note O – Dividends

Item 1. - Legal Proceedings

Forward-Looking Information

Management Overview

Forward-Looking Information

Management Overview

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the quarterly period ended September 30, 2005

or

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the transition period from to

Commission File Number: 1-4252

UNITED INDUSTRIAL CORPORATION

(Exact name of registrant as specified in its charter)

Delaware		95-2081809
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

124 Industry Lane, Hunt Valley, Maryland		21030
(Address of principal executive offices)		(Zip Code)

(410) 628-3500

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

	Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

	Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

	Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

	Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 11,260,879 shares of common stock as of October 20, 2005.

PART I - FINANCIAL INFORMATION

Item 1. - Financial Statements

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(Dollars in thousands)

	September 30, 2005			December 31, 2004
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	66,150		$	80,679
Marketable equity securities	13,109			—
Securities pledged to creditors	—			124,626
Restricted cash	4,812			33,845
Trade receivables, net	60,960			46,658
Inventories	33,073			34,639
Prepaid expenses and other current assets	10,095			12,465
Assets of discontinued operations	11,878			13,545
Total current assets	200,077			346,457
Deferred income taxes	11,455			13,930
Goodwill	4,833			—
Other assets	14,021			11,953
Insurance receivable - asbestos litigation	20,343			20,343
Property and equipment - less accumulated depreciation (2005-$78,794; 2004-$85,762)	40,204			27,645
	$	290,933		$	420,328
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	964		$	958
Payable under securities loan agreement	—			124,619
Accounts payable	22,390			21,664
Accrued employee compensation and taxes	18,163			13,706
Other current liabilities	15,387			14,942
Liabilities of discontinued operations	13,177			18,566
Total current liabilities	70,081			194,455
Long-term debt	121,053			122,000
Post-retirement benefit obligation other than pension, and other long-term liabilities	21,192			22,942
Minimum pension liability	21,193			17,513
Asbestos litigation liability	31,852			31,852
Total liabilities	265,371			388,762
Shareholders’ equity:
Preferred stock, par value $1.00 per share; 1,000,000 shares authorized; none issued and outstanding	—			—
Common stock, par value $1.00 per share; 30,000,000 shares authorized; 11,423,728 and 12,291,951 shares outstanding at September 30, 2005 and December 31, 2004, respectively (net of shares in treasury)	14,374			14,374
Additional capital	83,123			84,296
Retained earnings	30,331			3,499
Treasury stock, at cost; 2,950,420 and 2,082,197 shares at September 30, 2005 and December 31, 2004, respectively	(71,598		)	(40,019		)
Accumulated other comprehensive loss, net of tax	(30,668		)	(30,584		)
Total shareholders’ equity	25,562			31,566
Total liabilities and shareholders’ equity	$	290,933		$	420,328

See accompanying notes to the consolidated condensed financial statements.

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
Net sales	$	126,402		$	98,719		$	353,878		$	289,927
Cost of sales	96,768			73,958			267,916			219,629

Gross profit	29,634			24,761			85,962			70,298
Selling and administrative expenses	14,318			12,648			45,268			34,846
Other operating expenses, net	280			87			804			273
Operating income	15,036			12,026			39,890			35,179
Non-operating income and (expense):
Interest income	730			151			2,479			281
Interest expense	(1,424		)	(254		)	(4,642		)	(280		)
Gain on sale of property	—			—			7,152			—
Equity in net income of joint venture	114			15			166			75
Other income (loss), net	(41		)	72			796			160
	(621		)	(16		)	5,951			236
Income from continuing operations before income taxes	14,415			12,010			45,841			35,415
Provision for income taxes	5,101			4,266			15,602			12,626
Income from continuing operations	9,314			7,744			30,239			22,789
Income (loss) from discontinued operations, net of income tax provision of $330 and $736 for the three and nine months ended September 30, 2005 and tax benefit of $147 and $505 for the three and nine months ended September 30, 2004, respectively	112			(274		)	305			(939		)
Net income	$	9,426		$	7,470		$	30,544		$	21,850

Basic earnings per share:
Income from continuing operations	$	0.80		$	0.60		$	2.52		$	1.76
Income (loss) from discontinued operations	0.01			(0.02		)	0.02			(0.07		)
Net income	$	0.81		$	0.58		$	2.54		$	1.69
Diluted earnings per share:
Income from continuing operations	$	0.68		$	0.57		$	2.13		$	1.70
Income (loss) from discontinued operations	0.01			(0.02		)	0.02			(0.07		)
Net income	$	0.69		$	0.55		$	2.15		$	1.63

See accompanying notes to the consolidated condensed financial statements.

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

	Nine Months Ended September 30,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	30,544		$	21,850
Adjustments to reconcile net income to net cash provided by operating activities:
(Income) loss from discontinued operations, net of taxes	(305		)	939
Depreciation and amortization	6,268			4,149
Gain on sale of property	(7,152		)	—
Pension expense	3,680			3,318
Deferred income taxes	2,664			407
Income from equity investment in joint venture	(166		)	(75		)
Changes in operating assets and liabilities:
Increase in trade receivables	(11,930		)	(22,030		)
Decrease (increase) in inventories	2,247			(19,501		)
Decrease (increase) in prepaid expenses and other current assets	1,779			(754		)
Increase in customer advances	398			3,897
Increase in accounts payable, accruals and other current liabilities	3,504			13,204
Decrease in long-term liabilities	(1,752		)	(625		)
Other – net	859			138
Net cash provided by operating activities from continuing operations	30,638			4,917
Net cash used in discontinued operations	(3,418		)	(4,051		)
Net cash provided by operating activities	27,220			866
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(18,278		)	(2,864		)
Proceeds from sale of available-for-sale securities	124,626			—
Purchase of marketable equity securities	(12,780		)	—
Business acquisition, net of cash acquired	(9,883		)	—
Proceeds from sale of property	7,555			—
Net cash provided by (used in) investing activities	91,240			(2,864		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt	—			120,000
Debt issuance fees paid	—			(3,600		)
Repayment of long-term debt	(947		)	(668		)
Repayment of collateral received from securities lending transaction	(124,619		)	—
Decrease in restricted cash	29,033			—
Proceeds from exercise of stock options	1,474			3,352
Dividends paid	(3,705		)	(3,881		)
Purchase of treasury shares	(34,225		)	(34,842		)
Net cash (used in) provided by financing activities	(132,989		)	80,361
(Decrease) increase in cash and cash equivalents	(14,529		)	78,363
Cash and cash equivalents at beginning of year	80,679			24,138
Cash and cash equivalents at end of period	$	66,150		$	102,501

See accompanying notes to the consolidated condensed financial statements.

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Note A - Basis of Presentation and Nature of Operations

The accompanying unaudited Consolidated Condensed Financial Statements of United Industrial Corporation (“United Industrial”) and its subsidiaries (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. These unaudited Consolidated Condensed Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

On April 4, 2005, the Company acquired ESL Defence Limited (“ESL”), an electronic warfare systems company based in the United Kingdom. The operating results of ESL have been included in the consolidated financial statements of the Company since April 4, 2005.

The Company conducts a significant amount of business with the U.S. Government. No single customer other than the U.S. Government accounted for ten percent or more of consolidated net sales in any year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and those differences could be material.

Note B - Segment Information - Continuing Operations

The Company has two reportable segments: Defense and Energy. The operations of the Defense and Energy segments are conducted principally through two wholly-owned subsidiaries, AAI Corporation and its subsidiaries (“AAI”) and Detroit Stoker Company (“Detroit Stoker”), respectively. The Company measures its segment performance based on income (loss) before income taxes. Costs related to the continuing operations that are not identified with the two business segments primarily relate to financing costs and are grouped under the heading Other. The Company has a transportation operation that is accounted for as discontinued operations in the accompanying Consolidated Condensed Financial Statements.

(Dollars in thousands)	Defense		Energy		Other			Totals
Three Months Ended September 30, 2005
Net sales	$	116,815	$	9,587	$	—		$	126,402
Gross profit	25,832		3,802		—			29,634
Income from equity investment in joint venture	114		—		—			114
Interest income (expense), net	104		63		(861		)	(694		)
Depreciation and amortization expense	2,185		73					2,258
Income (loss) before income taxes	13,794		1,388		(767		)	14,415

Nine Months Ended September 30, 2005
Net sales	$	328,586	$	25,292	$	—		$	353,878
Gross profit	76,569		9,393		—			85,962
Income from equity investment in joint venture	166		—		—			166
Interest income (expense), net	220		150		(2,533		)	(2,163		)
Depreciation and amortization expense	6,045		223					6,268
Income (loss) before income taxes	45,453		2,478		(2,090		)	45,841

(Dollars in thousands)	Defense		Energy		Other			Totals
Three Months Ended September 30, 2004
Net sales	$	90,143	$	8,576	$	—		$	98,719
Gross profit	21,461		3,300		—			24,761
Income from equity investment in joint venture	15		—		—			15
Interest income (expense), net	49		5		(157		)	(103		)
Depreciation and amortization expense	1,299		88		—			1,387
Income (loss) before income taxes	10,957		1,185		(132		)	12,010

Nine Months Ended September 30, 2004
Net sales	$	266,510	$	23,417	$	—		$	289,927
Gross profit	61,285		9,013		—			70,298
Income from equity investment in joint venture	75		—		—			75
Interest income (expense), net	482		21		(502		)	1
Depreciation and amortization expense	3,889		260		—			4,149
Income (loss) before income taxes	33,192		2,648		(425		)	35,415

Basic earnings per share for all periods presented were computed by dividing net earnings for the respective period by the weighted-average number of shares of the Company’s common stock outstanding during the period. Diluted earnings per share was computed by dividing (i) net earnings during the period, adjusted to add back the after-tax interest charges incurred on the Company’s $120,000,000 aggregate principal amount of 3.75% Convertible Senior Notes due September 15, 2024, by (ii) the weighted-average number of shares of Common Stock outstanding during the period, adjusted to add the weighted-average number of potential dilutive common shares that would have been outstanding upon the assumed exercise of stock options and conversion of the 3.75% Convertible Senior Notes for Common Stock.

Options to purchase 189,000 shares of the Company’s Common Stock for the nine months ended September 30, 2005 and options to purchase 25,000 shares of the Company’s Common Stock for the three and nine months ended September 30, 2004 were not included in the computation of diluted earnings per share because their impact would be anti-dilutive.

Basic and diluted earnings per share amounts were computed as follows:

	Three Months Ended September 30,
	2005					2004
(Dollars in thousands, except per share data)	Earnings		Shares	Per Share		Earnings		Shares	Per Share

Basic Earnings Per Share
Income from continuing operations	$	9,314	11,652,025	$	0.80	$	7,744	12,810,916	$	0.60

Effect of Dilutive Securities
Stock Options	—		286,421			—		487,288
3.75% Convertible Senior Notes	855		3,058,356			148		498,645
Diluted Earnings Per Share
Income from continuing operations	$	10,169	14,996,802	$	0.68	$	7,892	13,796,849	$	0.57

	Nine Months Ended September 30,
	2005					2004
(Dollars in thousands, except per share data)	Earnings		Shares	Per Share		Earnings		Shares	Per Share

Basic Earnings Per Share
Income from continuing operations	$	30,239	12,012,831	$	2.52	$	22,789	12,958,288	$	1.76

Effect of Dilutive Securities
Stock Options	—		272,127			—		363,841
3.75% Convertible Senior Notes	2,449		3,058,356			148		167,428
Diluted Earnings Per Share
Income from continuing operations	$	32,688	15,343,314	$	2.13	$	22,937	13,489,557	$	1.70

For each of the three and nine month periods ended September 30, 2005 and 2004, the Company accounted for its stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and its related implementation guidance, whereby compensation cost for stock options is recognized in earnings based on the excess, if any, of the quoted market price of the stock at the grant date of the award or other measurement date over the amount an employee must pay to acquire the stock. Had compensation cost been determined consistent with the fair value method set forth under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS No. 148”), for all awards under the plans, income and earnings per share from continuing operations would have decreased to the pro forma amounts indicated below:

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands, except per share data)	2005			2004			2005			2004
Income from continuing operations:
As reported	$	9,314		$	7,744		$	30,239		$	22,789
Deduct: Total employee stock-based compensation expense determined under fair value method for all awards, net of tax	(198		)	(152		)	(665		)	(404		)
Pro forma	$	9,116		$	7,592		$	29,574		$	22,385
Earnings per share from continuing operations:
As reported:
Basic	$	0.80		$	0.60		$	2.52		$	1.76
Diluted	0.68			0.57			2.13			1.70
Pro forma:
Basic	$	0.78		$	0.59		$	2.46		$	1.73
Diluted	0.66			0.56			2.09			1.67

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which replaced SFAS No. 123 and superseded SFAS No. 148 and APB No. 25 and its related implementation guidance. SFAS No. 123R requires entities to recognize in their financial statements the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). SFAS No. 123R is effective for the Company as of the interim period that begins January 1, 2006. The Company has not yet determined which method of adoption it will select. Any impact recognized in the fair value of awards is not an allowable cost and will impact our net income.

Inventories consisted of the following components:

(Dollars in thousands)	September 30, 2005		December 31, 2004
Finished goods and work-in-process	$	31,071	$	33,384
Materials and supplies	2,002		1,255
Total inventories	$	33,073	$	34,639

Other assets consisted of the following components:

(Dollars in thousands)	September 30, 2005		December 31, 2004
Intangibles, net	$	6,063	$	4,060
Debt issuance costs, net	3,884		4,620
Investment in joint venture	1,782		1,616
Other	2,292		1,657
Total other assets	$	14,021	$	11,953

Other current liabilities consisted of the following components:

(Dollars in thousands)	September 30, 2005		December 31, 2004
Customer advances	$	5,974	$	5,576
Accrual for contract losses	2,486		1,680
Accrued interest expense	224		1,364
Accrued liabilities	4,070		2,864
Other	2,633		3,458
Total other current liabilities	$	15,387	$	14,942

Cash paid for Federal income taxes during the nine months ended September 30, 2005 and 2004 was $10,100,000 and $6,680,000 respectively. Cash paid for interest during the nine months ended September 30, 2005 and 2004 was $4,550,000 and $53,000 respectively.

On December 29, 2004, the Company purchased $125,000,000 aggregate principal amount at maturity of U.S. treasury bills for $124,619,000, which matured on February 24, 2005. The Company classified this investment as available-for-sale, which required it to be reported at estimated fair value, with unrealized gains and losses, net of tax, reported as a separate component of Accumulated Other Comprehensive Loss in Shareholders’ Equity until realized. Concurrently with the purchase of the U.S. treasury bills on December 29, 2004, the Company entered into a securities lending transaction with its broker-dealer, which matured on February 23, 2005 and was accounted for as a secured borrowing. In exchange for lending the U.S. treasury bills to its broker-dealer, the Company received cash collateral from its broker-dealer in an amount equal to 100% of the fair value of the securities loaned, net of a $25,000,000 refundable deposit that remained at its broker-dealer in a segregated, interest-bearing account. At maturity on February 23, 2005, the Company repaid the cash collateral received, together with approximately $444,000 of related interest charges. Also at maturity, the Company collected its $25,000,000 refundable deposit, together with approximately $86,000 of related interest income earned. During the first quarter of 2005, the Company realized a $7,500 loss on this investment, excluding approximately $373,000 of interest income received.

Note I - Pension and Other Post-retirement Benefits

The following table provides the components of net periodic pension benefit cost for the three and nine months ended September 30, 2005 and 2004:

	Pension Benefits Three Months Ended September 30,						Pension Benefits Nine Months Ended September 30,
(Dollars in thousands)	2005			2004			2005			2004
Service cost	$	819		$	736		$	2,437		$	2,236
Interest cost	2,576			2,651			7,733			7,794
Expected return on plan assets	(3,213		)	(3,146		)	(9,632		)	(9,460		)
Net amortization and deferral:
Amortization of prior service cost	69			46			207			136
Amortization of actuarial loss	1,019			1,200			3,128			2,887
Net periodic pension benefit cost	$	1,270		$	1,487		$	3,873		$	3,593

The following table provides the components of other post-retirement benefit cost for the three and nine months ended September 30, 2005 and 2004:

	Other Post-retirement Benefits Three Months Ended September 30,						Other Post-retirement Benefits Nine Months Ended September 30,
(Dollars in thousands)	2005			2004			2005			2004
Service cost	$	48		$	37		$	143		$	130
Interest cost	297			327			890			952
Net amortization and deferral:
Amortization of prior service cost	(5		)	(11		)	(14		)	(31		)
Amortization of actuarial loss	3			41			9			—
Other post-retirement benefit cost	$	343		$	394		$	1,028		$	1,051

The following table provides the Company’s contributions to and benefits paid under pension and other post-retirement benefit plans:

	Pension Benefits Nine Months Ended September 30,				Other Post-retirement Benefits Nine Months Ended September 30,
(Dollars in thousands)	2005		2004		2005		2004

Expected fiscal year contributions reported at the end of the prior year:
Employer	$	244	$	259	$	3,007	$	2,572
Employee	—		—		—		172
	244		259		3,007		2,744

Actual contributions made in the current year	193		223		2,347		2,058
Remaining contributions expected to be made in the current year	51		36		752		686
Total expected current year contributions	244		259		3,099		2,744
Difference from expectations at end of the prior year	$	—	$	—	$	92	$	—

Effective July 1, 2004, the Company adopted FSP No. FAS 106-2 and includes the effects of the Medicare Act of 2003 in its measurement of net periodic post-retirement benefit cost and accumulated post-retirement benefit obligations (“APBO”).

Note J - Other Operating Expenses, Net and Other Non-Operating Income, Net

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2005			2004			2005			2004

Other operating expenses, net
Amortization of intangible assets	$	55		$	55		$	166		$	166
Amortization of facility consolidation costs	47			64			136			210
Amortization of deferred compensation liability	(16		)	(25		)	(48		)	(81		)
Asbestos litigation expense	208			—			422			—
Other (income) expense, net	(14		)	(7		)	128			(22		)
Total other operating expenses, net	$	280		$	87		$	804		$	273

Other non-operating income (expense), net
Royalties and commissions	$	23		$	14		$	41		$	70
Rental income	14			14			44			42
Gain from change in fair value of embedded derivatives underlying long-term debt	81			—			382			—
Other income (expense), net	(159		)	44			329			48
Total other non-operating income (expense), net	$	(41	)	$	72		$	796		$	160

The following table sets forth the components of other comprehensive income and total comprehensive income:

	Three Months Ended September 30,					Nine Months Ended September 30,
(Dollars in thousands)	2005			2004		2005			2004

Net income	$	9,426		$	7,470	$	30,544		$	21,850
Other comprehensive income (loss), net of tax:
Minimum pension liability, net of tax of $627 in 2004	—			—		—			627
Unrealized gain on marketable securities	179			—		334			—
Loss on foreign currency translation	(176		)	—		(418		)	—
Total comprehensive income	$	9,429		$	7,470	$	30,460		$	22,477

Note L – Acquisitions

On April 4, 2005, the Company acquired ESL, an electronic warfare systems company based in the United Kingdom. The net purchase price was $10,363,000 in cash. The operating results of ESL have been included in the consolidated financial statements of the Company since April 4, 2005. The purchase price of this business has been preliminarily allocated to the estimated fair value of net tangible and intangible assets acquired, with any excess recorded as goodwill. The estimates related to the acquired assets and liabilities have not been finalized at September 30, 2005, specifically, the Company is awaiting the completion of the identification and valuation of intangible assets acquired. The Company expects these analyses to be completed by December 2005.

The following table summarizes the preliminary estimated fair value of the assets and liabilities assumed at April 4, 2005.

(Dollars in thousands)	At April 4, 2005

Cash and equivalents	$	479
Current assets	3,054
Property and equipment	384
Intangible assets	2,486
Goodwill	5,684
Total assets acquired	12,087

Current liabilities	1,724
Total liabilities assumed	1,724
Net assets acquired	$	10,363

The acquired intangible assets, all of which are being amortized and relate primarily to contract related intangibles, have an estimated weighted average useful life of approximately seven years. The goodwill is expected to be fully deductible for U.S. tax purposes. Aggregate amortization expense for amortizing intangible assets was $173,010 at September 30, 2005. Estimated amortization expense for the next five years is $258,691 in 2005, $342,724 in 2006, $342,724 in 2007, $342,724, in 2008, and $342,724 in 2009. This acquisition is not considered to be material, so, pro-forma information is not presented.

Assets and liabilities of the discontinued transportation operations, which have been reclassified to Assets of discontinued operations and Liabilities of discontinued operations and summarized in the accompanying Consolidated Condensed Balance Sheets, respectively, were as follows:

(Dollars in thousands)	September 30, 2005			December 31, 2004
Current assets:
Trade receivables from affiliate	$	39,322		$	39,322
Less allowances	(39,322		)	(39,322		)
Prepaid expenses and other current assets	51			51
Deferred taxes	11,827			13,494
Other receivables from affiliate	12,957			11,278
Less allowances	(12,957		)	(11,278		)
Total current assets	$	11,878		$	13,545
Current liabilities:
Accounts payable	$	174		$	937
Accrued employee compensation and taxes	141			164
Other current liabilities	11,270			11,270
Accrual for contract losses	1,592			6,164
Other	—			31
Total current liabilities	$	13,177		$	18,566

Summary results of the transportation operations, which have been classified separately as discontinued operations, were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2005			2004			2005			2004
Revenue	$	—		$	—		$	—		$	—
Income (loss) before income taxes	442			(421		)	1,041			(1,444		)
(Provision for) benefit from income taxes	(330		)	147			(736		)	505
Income (loss) from discontinued transportation operations, net of income taxes	$	112		$	(274	)	$	305		$	(939	)

	Nine Months Ended September 30,
(Dollars in thousands)	2005			2004
Net cash provided by (used in) discontinued operations:
Net income (loss)	$	305		$	(939	)
Changes in operating assets and liabilities	(787		)	(397		)
Increase in deferred income tax assets	1,667			819
Decrease in accrual for contract losses and other	(4,603		)	(3,534		)
Net cash used in discontinued transportation operations	$	(3,418	)	$	(4,051	)

Note N - Commitments and Contingencies

In the normal course of its continuing and discontinued business, various lawsuits, claims and legal proceedings have been or may be instituted or asserted against or by the Company. Based on currently available facts, the Company believes, except as otherwise set forth below, that the disposition of matters pending or asserted against the Company will not have a material adverse effect on the Company’s financial position, results of operations or liquidity.

ASBESTOS

History

United Industrial and Detroit Stoker, have been named as defendants in asbestos-related personal injury litigation. Neither United Industrial nor Detroit Stoker fabricated, milled, mined, manufactured or marketed asbestos, and neither United Industrial nor Detroit Stoker made or sold insulation products or other construction materials that have been identified as the primary cause of asbestos-related disease in the vast majority of claimants. Rather, United Industrial and Detroit Stoker made several products, some of the parts and components of which used asbestos-containing material fabricated and provided by third parties. The use of asbestos-containing materials ceased in approximately 1981.

Cases involving United Industrial and Detroit Stoker typically name 80 to 120 defendants, although some cases have as few as 6 and as many as 250 defendants. As of this date, United Industrial and Detroit Stoker have not gone to trial with respect to any asbestos-related personal injury claims, although there is no assurance that trials may not occur in the future. Accordingly, as of this date, neither United Industrial nor Detroit Stoker have been required to pay any punitive damage awards, although there can be no assurance this might not occur in the future. In addition, as of this date, some previously pending claims have been settled or dismissed (with or without prejudice). There is no assurance, however, that dismissals and settlements will occur at the same rate, if at all, or that claims that have been dismissed without prejudice will not be re-filed.

Defenses

Management continues to believe that a majority of the claimants in pending cases will not be able to demonstrate that they have been exposed to United Industrial’s or Detroit Stoker’s asbestos-containing products or suffered any compensable loss as a result of any such exposure. This belief is based in large part on two factors: the limited number of asbestos-containing products and betterments sold by United Industrial and Detroit Stoker and United Industrial’s and Detroit Stoker’s access to sales, service, and other historical business records going back over 100 years, which allow United Industrial and Detroit Stoker to determine to whom products were sold, the date of sale, the installation site and, in some instances, the date products were removed from service. In addition, because of the limited and restricted placement of the asbestos-containing products, even at sites where a claimant can verify his or her presence during the same period those products were installed, liability cannot be presumed because, even if an individual contracted an asbestos-related disease, not everyone who was employed at a site was exposed to United Industrial’s or Detroit Stoker’s asbestos-containing products.

These factors have allowed United Industrial and Detroit Stoker to effectively manage their asbestos-related claims.

Settlements

To date, settlements of claims against United Industrial and/or Detroit Stoker have been made without any admission of liability by United Industrial and/or Detroit Stoker. Settlement amounts may vary depending upon a number of factors, including the jurisdiction where the action was brought, the nature and extent of the disease alleged and the associated medical evidence, the age and occupation of the claimant, the existence or absence of other possible causes of the claimant’s alleged illness, and the availability of legal defenses, as well as whether the action is brought alone or as part of a group of claimants. Before paying any settlement amount, United Industrial and/or Detroit Stoker require proof of exposure to their asbestos-containing products and proof of injury to the plaintiff. In addition, the claimant is required to execute a release of United Industrial, Detroit Stoker and associated parties, from any liability for asbestos-related injuries or claims.

Insurance Coverage

The insurance coverage potentially available to United Industrial and Detroit Stoker is substantial. Following the institution of asbestos litigation, an effort was made to identify all of United Industrial’s and Detroit Stoker’s primary and excess insurance carriers from 1940 through 1990. There were approximately 40 such carriers, all of which were put on notice of the litigation. In November of 1999, a Participation Agreement was entered into among United Industrial, Detroit Stoker and their primary insurance carriers. The Participation Agreement is an advance understanding that supplements all of the contracts of insurance, without altering the coverage of those contracts, that creates an administrative framework within which the insurers and United Industrial and Detroit Stoker can more efficiently and effectively manage the large quantity of on-going litigation.

Any party may terminate the Participation Agreement, without cause, by giving the other parties 60 days prior written notice. Termination of the Participation Agreement does not affect any rights or obligations of the parties that have accrued under the Participation Agreement on or before the effective date of the termination, nor does it affect any rights outside of the Participation Agreement.

Although the carriers can opt out of the Participation Agreement on 60 days notice, management does not believe that this will occur in the immediate or near term. For example, unless a carrier professes to have met the limits of its liability, it would have to consider the potentially greater costs of permitting United Industrial and Detroit Stoker to handle their own cases. Further, opting out of the Participation Agreement does not exculpate liability on the part of the carrier.

United Industrial’s counsel retained a consulting firm with expertise in the field of evaluating insurance coverage and the likelihood of recovery for claims, such as costs incurred in connection with asbestos-related injury claims. In 2002, that firm worked with United Industrial to project the insurance coverage of United Industrial and Detroit Stoker for asbestos-related claims. The insurance consultant’s conclusions were based primarily on a review of United Industrial’s and Detroit Stoker’s coverage history, application of reasonable assumptions on the allocation of coverage consistent with industry standards, an assessment of the creditworthiness of the insurance carriers, and the experience of and a review of the report of the asbestos liability consultant described below. The insurance consultant also considered the Participation Agreement.

Based on the assumptions employed by and the report prepared by the insurance consultant, other variables, and the report prepared by the asbestos liability consultant, which is discussed below, the Company recorded an estimated insurance recovery as of December 31, 2002, of $20,343,000 reflecting the estimate determined to be probable of being available to mitigate United Industrial’s and Detroit Stoker’s potential asbestos liability through 2012. The Company continuously evaluates this insurance receivable and believes it is appropriately valued at September 30, 2005.

Quantitative Claims Information

As of September 30, 2005, United Industrial and/or Detroit Stoker were named in asbestos litigation pending in Arkansas, California, Louisiana, Michigan, Minnesota, Mississippi, New Jersey, New York and North Dakota. As of September 30, 2005, there were approximately 12,897 pending claims, compared to approximately 21,123 pending claims as of December 31, 2004 and approximately 21,114 pending claims as of September 30, 2004. During 2004, Detroit Stoker was named as a defendant in two cases in Arkansas alleging personal injuries to one and approximately 199 plaintiffs, respectively, as a result of silica and/or refractory ceramic fiber exposure in addition to asbestos exposure. The pleadings in these two cases name approximately 32 and 68 defendants, respectively, and include no allegations specific to Detroit Stoker. Because claims are often filed and disposed of by dismissal or settlement in large numbers, the amount and timing of settlements and the number of open claims during a particular period can fluctuate from period to period and may not be indicative of the trend in future claims, settlements or dismissals. In addition, most of these lawsuits do not include specific dollar claims for damages, and many include a number of plaintiffs and multiple defendants. Therefore, the Company cannot provide any meaningful disclosure about the total amount of the damages sought. In addition, the direct asbestos-related expenses of United Industrial and Detroit Stoker for defense and indemnity for the past five years were not material.

A significant increase in the volume of asbestos-related bodily injury cases arose in Mississippi beginning in 2002 and extended through mid-year 2003. Management believes this peak in the volume of claims in Mississippi was due to the passage of tort reform legislation (applicable to asbestos-related injuries), which became effective at the end of 2002 and which resulted in a large number of claims being filed in Mississippi by plaintiffs seeking to ensure their claims would be governed by the law in effect prior to the passage of tort reform.

In 2002, United Industrial’s counsel engaged a consulting firm with expertise in the field of evaluating asbestos bodily-injury claims to assist United Industrial in projecting the future asbestos-related liabilities and defense costs of United Industrial and Detroit Stoker. The methodology used by this asbestos liability consultant to project future asbestos-related costs is based primarily on estimates of the labor force exposed to asbestos in United Industrial’s and Detroit Stoker’s products, epidemiological modeling of asbestos-related disease manifestation, and estimates of claim filings and settlement and defense costs that may occur in the future. Using this information, the asbestos liability consultant estimated the number of future claims that would be filed, as well as the related costs that would be incurred in resolving those claims. United Industrial’s and Detroit Stoker’s claims history prior to 2002 was not a significant variable in developing the estimates because such history was not significant as compared to the number of claims filed in 2002.

Projecting future asbestos costs is subject to numerous variables that are extremely difficult to predict. In addition to the significant uncertainties surrounding the number of claims that might be received, other variables include the type and severity of the disease alleged by each claimant, the long latency period associated with asbestos exposure, dismissal rates, costs of medical treatment, the impact of bankruptcies of other companies that are co-defendants in claims, uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case, and the impact of potential changes in legislative or judicial standards. Furthermore, any predictions with respect to these variables are subject to even greater uncertainty as the projection period lengthens. In light of these inherent uncertainties, United Industrial’s and Detroit Stoker’s limited claims history prior to 2002 and consultation with the asbestos and insurance consultants, the Company believes that ten years is the most reasonable period for recognizing a reserve for future costs, and that costs that might be incurred after that period were not reasonably estimable. As a result, the Company also believes that its ultimate net asbestos-related contingent liability (i.e. its indemnity or other claim disposition costs plus related legal fees less insurance recoveries) cannot be estimated with certainty.

Based on the assumptions employed by and the report prepared by the asbestos liability consultant and other variables, the Company recorded an undiscounted liability for its best estimate of bodily injury liabilities for asbestos-related matters in the amount of $31,852,000 as of December 31, 2002, including damages and defense costs.

Given the inherent uncertainty in making future projections and that United Industrial and Detroit Stoker periodically receive potentially material new information from claimants and their counsel that relates to the factual basis of their asserted and unasserted claims, United Industrial and Detroit Stoker plan on a periodic basis, to have either (1) the key assumptions used in projecting the future asbestos-related liabilities and defense costs of United Industrial and Detroit Stoker validated or (2) the projections of current and future asbestos claims re-examined, and United Industrial and Detroit Stoker will update them if needed based on the experience of United Industrial and Detroit Stoker and other relevant factors, such as changes in the tort system and the resolution of bankruptcies of various asbestos defendants.

In connection with the preparation of its annual report on Form 10-K for the year ended December 31, 2004, United Industrial provided the asbestos consulting firm with updated information regarding asbestos cases filed against United Industrial and/or Detroit Stoker, and asked the consulting firm to perform a validation of its 2002 report. In particular, the consulting firm was asked if it would use the same methodology to calculate future asbestos liability and if the assumptions used in 2002 are still valid. The consulting firm reported that nothing had come to their attention in the intervening period that would call into question the central assumptions underlying the report, or the report’s ten-year estimate of United Industrial’s and Detroit Stoker’s future potential liability. The Company’s asbestos liability was $31,852,000 and $31,334,000 at September 30, 2005 and 2004, respectively, and its insurance receivables for asbestos-related liabilities were $20,343,000 and $20,236,000 at September 2005 and 2004, respectively. These figures reflect the Company’s policy of maintaining a ten-year estimate of future liability, the period in which such costs are deemed to be reasonably estimable.

In light of the asbestos liability consultant’s reports and based upon the facts as now known, including the reasonable possibility that claims will be received and paid over the next 50 year period, the Company believes that although asbestos claims could have a material adverse effect on the Company’s financial condition or results of operations in a particular reporting period, asbestos claims should not have a material adverse effect on the Company’s long term financial condition, liquidity or results of operations. No assurances can be given, however, as to the actual amount of United Industrial’s and Detroit Stoker’s liability for such present and future claims or the amount of insurance recoveries (including any recoveries from liquidating excess insurance carriers), and the differences from estimated amounts could be material.

Reform Legislation

The outlook for federal legislation to provide national asbestos litigation reform continues to be uncertain. Also uncertain is whether, and to what extent, United Industrial and Detroit Stoker would be required to make contributions to a prospective national asbestos trust pursuant to such legislation. No assurances can be given that a proposed trust or any other asbestos legislation will ultimately become law, or when such action might occur.

STATE OF ARIZONA DEPARTMENT OF ENVIRONMENTAL QUALITY V. UIC, ET AL.

On May 19, 1993, United Industrial was named as one of three defendants in a civil action brought pursuant to the Comprehensive Environmental Response Compensation and Liability Act (“CERCLA”) by the Arizona Department of Environmental Quality (“ADEQ”) in the United States District Court for the District of Arizona. ADEQ sought remediation of a manufacturing site in the State of Arizona operated by U.S. Semiconductor Products, Inc. (“U.S. Semiconductor”), a manufacturer of semiconductors formerly owned by United Industrial. ADEQ alleged that from 1959 until United Industrial sold U.S. Semiconductor in 1961, U.S. Semiconductor disposed of tricholoroethylene, a “hazardous substance,” and other hazardous substances under CERCLA, onto the ground and into various pits and drains located on the site.

In 1996, United Industrial entered into a consent decree with ADEQ. Pursuant to the consent decree, United Industrial is required to complete a Remedial Investigation/Feasibility Study (“RI/FS”), pay $125,000 for past response costs, pay quarterly Arizona oversight costs (averaging less than $10,000 annually) and pay $125,000 for future response costs plus a graduated percentage of the cleanup costs for the site if those costs are in excess of $10,000,000 but less than $40,000,000. United Industrial’s liability for future response costs under the consent decree is capped at $1,780,000 in addition to the $125,000 that United Industrial has already paid. In connection with the RI/FS, United Industrial has retained and is paying for an environmental consultant. The Remedial Investigation was submitted to ADEQ for approval on March 31, 2004 and was approved by ADEQ on August 9, 2004. In March 2005, ADEQ issued its Proposed Remedial Objectives Report for public comment. ADEQ received no substantive comments regarding the report, and in May 2005, ADEQ issued is final Remedial Objectives Report. United Industrial is required to submit to ADEQ a Feasibility Study and Proposed Remedies to meet ADEQ’s May 2005 Remedial Objectives. Management believes that it will reach closure with ADEQ on all RI/FS issues on an acceptable basis to United Industrial following approval of the Feasibility Study. No assurances can be given, however, as to the actual extent to which United Industrial may be determined to have further liability, if at all.

MICHIGAN DEPARTMENT OF NATURAL RESOURCES

Detroit Stoker was notified in March 1992 by the Michigan Department of Natural Resources (“MDNR”) that it is a potentially responsible party in connection with the cleanup of a former industrial landfill located in Port of Monroe, Michigan. MDNR is treating the Port of Monroe landfill site as a contaminated facility within the meaning of the Michigan Environmental Response Act (“MERA”). Under MERA, if a release or potential release of a discarded hazardous substance is or may be injurious to the environment or to the public health, safety or welfare, MDNR is empowered to undertake or compel investigation and response activities in order to alleviate any contamination threat. Management believes Detroit Stoker would be considered a de minimis potentially responsible party and does not believe that the resolution of this matter will have a materially adverse effect on United Industrial’s or Detroit Stoker’s financial condition or results of operations. No assurances can be given, however, as to the actual extent to which Detroit Stoker may be determined to be liable, if at all.

OTHER LEGAL MATTERS

Departments and agencies of the U.S. Government have the authority at many levels to investigate transactions and operations of the Company, and the results of such investigations may lead to administrative, civil, or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments or compensatory or treble damages. Agencies that oversee contract performance include: the Defense Contract Audit Agency, the Department of Defense Inspector General, the General Accounting Office, the Department of Justice, the Department of State, and Congressional Committees. U.S. Government regulations provide that certain findings against a contractor may lead to suspension or debarment from future U.S. Government contracts or the loss of export privileges for a company or an operating division or subdivision.

The Company has in place international and domestic compliance policies and procedures, including training of employees. From time to time, the Company receives allegations of improper conduct relating to its operations, including operations subject to the U.S. Foreign Corrupt Practices Act and other U.S. domestic and international laws. When the Company receives any such allegations, it conducts internal (and if necessary, external) investigations to determine whether there is support for any such allegations. An investigation is ongoing in response to allegations provided to Company management of improper payments to foreign government officials and improper invoicing. External counsel has been retained by the Audit Committee of the Company’s Board of Directors to determine if there is support for any such allegations, and to review the Company’s compliance policies and procedures, and the Company is cooperating fully with counsel. In addition, appropriate government agencies have been advised of this investigation. The Company is cooperating with their requests for information. The investigation by external counsel, which is continuing, has thus far not revealed any prior involvement or knowledge regarding the allegations by any officer or director of United Industrial. At the current stage of this investigation, any ultimate liability is not presently determinable.

PERFORMANCE GUARANTIES

In connection with certain contracts, United Industrial’s operating subsidiaries have committed to certain performance guaranties existing at September 30, 2005. The ability to perform under these guaranties may, in part, be dependent on the performance of other parties, including partners and subcontractors. If United Industrial’s operating subsidiaries are unable to meet these performance obligations, the performance guaranties could have a material adverse effect on profit margins and the Company’s results of operations, liquidity or financial position. United Industrial’s operating subsidiaries monitor the progress of their partners and subcontractors, and United Industrial and its operating subsidiaries do not believe that the performance of these partners and subcontractors will adversely affect these contracts. No assurances can be given, however, as to the liability of United Industrial’s operating subsidiaries if partners or subcontractors are unable to perform their obligations.

DISCONTINUED TRANSPORTATION OPERATION

In connection with the discontinued Transportation operations, AAI owns 35% of Electric Transit, Inc. (“ETI”). Skoda a.s. (“Skoda”), a Czech company, owns the remaining 65% of ETI. ETI’s one remaining production contract with the San Francisco Municipal Railway (“MUNI”) involves the design and manufacture of 273 electric trolley buses (“ETBs”). In executing its contract with MUNI, ETI entered into subcontracts with AAI, certain Skoda operating affiliates and others. AAI and the Skoda operating affiliates have completed delivery of their respective scopes of work to support the delivery of the ETB’s to MUNI and the Skoda operating affiliates are now subject to warranty requirements. Skoda’s operating affiliates have continued to deliver products and services under their subcontracts with ETI through September 2005.

Following Skoda’s bankruptcy declaration in 2001 in the Czech Republic, effective as of 2002, AAI began recording 100%, instead of 35%, of ETI’s losses and income in accordance with the equity method of accounting applicable to minority shareholders. Although AAI has completed performance on its subcontract with ETI on the MUNI contract, AAI has continued to provide ETI with personnel and other financial support in order to enable ETI to satisfy certain of its remaining commitments to MUNI.

As of April 22, 2004, ETI and MUNI finalized an agreement to modify the original MUNI contract (“Modification No. 6”) under which ETI assigned its remaining subcontractor obligations to MUNI and MUNI relieved ETI of its warranty, performance and certain related bonding obligations, as well as other obligations under its ETB contract with MUNI, except for the performance of a defined scope of work related to modifications of ETB hardware, which have been completed.

In conjunction with Modification No. 6, AAI executed a guaranty agreement with MUNI as of April 22, 2004 (the “Guaranty Agreement”) that assures performance of certain of ETI’s obligations under Modification No. 6. In conjunction with the Guaranty Agreement, AAI obtained a release from its subcontrctor warranty and all further obligations under its subcontract in exchange for a cash payment to MUNI of $500,000 and other consideration. AAI’s sole remaining

obligation under the Guaranty Agreement is to provide the services of three engineers and one purchasing expediter through April 2006. The Company believes that it has adequately provided for its obligations under the Guaranty Agreement in its existing loss reserves.

As required by MUNI, ETI obtained a surety bond to guaranty payment to all those providing labor and materials to ETI in furtherance of its performance under the MUNI contract. AAI agreed to indemnify the surety, if necessary, for up to $14,800,000 on this labor and materials bond, representing 35% of the original face value of the bond (in proportion to AAI’s equity interest in ETI). On November 18, 2003, AAI provided the surety with notice of its claim against the labor and materials bond for unpaid receivables in connection with AAI’s MUNI subcontract from ETI, totaling in excess of $47,000,000, the maximum penal sum of the labor and materials bond. AAI’s payment rights under the labor and materials bond (among other claims) are currently at issue in a case before the Federal court in the Northern District of California. Prior to final adjudication of this case, there can be no assurances as to the amount or timing of a recovery by AAI, if any, on its claim on the labor and materials bond. To date no amount of recovery has been recorded by AAI.

The Company’s Board of Directors declared a dividend of $0.10 per share on its common stock for each quarter for the nine months ended September 30, 2005 and 2004.

For the quarter ended	Total amount dividends paid		Date dividends were paid
March 31, 2005	$	1,230,089	March 31, 2005
June 30, 2005	$	1,234,479	May 30, 2005
September 30, 2005	$	1,239,459	August 31, 2005
March 31, 2004	$	1,313,236	March 31, 2004
June 30, 2004	$	1,292,646	May 28, 2004
September 30, 2004	$	1,305,109	August 17, 2004

Note P – Issuer Purchases of Equity Securities

On September 7, 2005, the Board of Directors of the Company authorized a stock purchase plan for up to $15,000,000. The Company repurchased a total of 262,578 shares with an average price of $35.22 during the three months ended September 30, 2005. As of September 30, 2005, there remained $5,744,000 available under the subject authorization for future purchases. During October 2005, an additional 163,049 shares were purchased with an average purchase price of $35.16, utilizing the remaining funds under the plan.

On March 10, 2005, the Company’s Board of Directors of the Company authorized a stock purchase plan for up to $25,000,000. During the first six months of 2005, a total of 735,345 shares were repurchased under the plan for an aggregate amount of $25,000,000, or an average price of $33.97 per share, utilizing all funds available under the March 10, 2005 stock purchase plan.

In September 2004, the Company purchased 850,400 shares of its Common Stock for approximately $24,356,000, or $28.64 per share, using a portion of the net proceeds from the issuance and sale in September 2004 of the 3.75% Convertible Senior Notes. These shares were purchased concurrently with the sale of the 3.75% Convertible Senior Notes in privately negotiated transactions.

In November 2003, the Board of Directors of the Company authorized the purchase of up to $10,000,000 of the Company’s Common Stock. On March 10, 2004, the Company’s Board of Directors extended the plan for one additional year through March 15, 2005, and authorized the purchase of up to an additional $10,000,000 of Common Stock. From inception of this plan in November 2003 to its expiration on March 15, 2005, the Company had purchased a total of 917,700 shares for $16,522,000, or an average of $18.00 per share. The remaining $3,478,000 was not used and expired on March 15, 2005.

Note Q - Restructuring Charges

(Dollars in thousands)	Severance			Employee Relocation			Facility Relocation			Facility Closing Costs			Total

Defense segment
Reserve balance at December 31, 2004	$	160		$	169		$	74		$	—		$	403
Restructuring charges	349			418			—			1,161			1,928
Paid or otherwise settled	(436		)	(587		)	(74		)	(1,161		)	(2,258		)
Reserve balance at September 30, 2005	$	73		$	—		$	—		$	—		$	73

Energy segment
Reserve balance at December 31, 2004	$	—		$	—		$	—		$	—		$	—
Restructuring charges	88			—			61			84			233
Paid or otherwise settled	(88		)	—			(61		)	(84		)	(233		)
Reserve balance at September 30, 2005	$	—		$	—		$	—		$	—		$	—

Note R - Supplemental Guarantor Information

In September 2004, United Industrial issued and sold $120,000,000 aggregate principal amount of 3.75% Convertible Senior Notes, which are fully and unconditionally guarantied by AAI, the Company’s wholly-owned subsidiary that constitutes the Defense segment. The 3.75% Convertible Senior Notes are not guarantied by Detroit Stoker, the Company’s wholly-owned subsidiary that constitutes the Energy segment. The following condensed consolidating financial information sets forth supplemental information for United Industrial, the parent company, AAI, the guarantor subsidiary, and Detroit Stoker, the non-guarantor subsidiary, as of September 30, 2005 and December 31, 2004, and for the three-month and nine-month periods ended September 30, 2005 and 2004.

CONDENSED CONSOLIDATING FINANCIAL INFORMATION

CONDENSED CONSOLIDATING BALANCE SHEETS

As of September 30, 2005

(Dollars in thousands)

(Unaudited)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)			Detroit Stoker Company (Non- Guarantor)			Eliminations			United Industrial Corporation and Subsidiaries

ASSETS
Current Assets
Cash and cash equivalents	$	52,335		$	3,272		$	10,543		$	—		$	66,150
Marketable equity securities	13,109			—			—			—			13,109
Securities pledged to creditors
Restricted cash	—			4,812			—			—			4,812
Trade receivables, net	459			56,331			4,170			—			60,960
Inventories	(516		)	30,616			2,973			—			33,073
Other current assets	991			8,488			815			(199		)	10,095
Assets of discontinued operations	—			11,878			—			—			11,878
Total current assets	66,378			115,397			18,501			(199		)	200,077
Insurance receivable - asbestos litigation	—			—			20,343			—			20,343
Property and equipment, net	—			38,390			1,814						40,204
Other assets	11,520			33,406			2,493			(17,110		)	30,309
Intercompany receivables	—			293			—			(293		)	—
Investment in consolidated subsidiaries	76,806			—			—			(76,806		)	—
	$	154,704		$	187,486		$	43,151		$	(94,408	)	$	290,933

LIABILITIES AND SHAREHOLDERS’EQUITY
Current portion of long-term debt	$	—		$	964		$	—		$	—		$	964
Other current liabilities	3,869			62,021			5,606			(15,556		)	55,940
Liabilities of discontinued operations	—			13,177			—			—			13,177
Total current liabilities	3,869			76,162			5,606			(15,556		)	70,081
Long-term debt	120,000			1,053			—			—			121,053
Asbestos litigation liability	—			—			31,852			—			31,852
Other long-term liabilities	2,809			44,835			11,851			(17,110		)	42,385
Intercompany (receivables) payables	35,199			(50,633		)	345			15,089			—
Shareholders’ equity (deficit)	(7,173		)	116,069			(6,503		)	(76,831		)	25,562
	$	154,704		$	187,486		$	43,151		$	(94,408	)	$	290,933

CONDENSED CONSOLIDATING BALANCE SHEETS

As of December 31, 2004

(Dollars in thousands)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)		Detroit Stoker Company (Non- Guarantor)			Eliminations			United Industrial Corporation and Subsidiaries

ASSETS
Current assets:
Cash and cash equivalents	$	129		$	72,269	$	8,281		$	—		$	80,679
Securities pledged to creditors	124,626			—		—			—			124,626
Restricted cash	25,000			8,845		—			—			33,845
Trade receivables, net	17			44,152		2,489			—			46,658
Inventories	—			31,957		2,682			—			34,639
Other current assets	3,295			8,283		909			(22		)	12,465
Assets of discontinued operations	—			13,545		—			—			13,545
Total current assets	153,067			179,051		14,361			(22		)	346,457
Insurance receivable - asbestos litigation	—			—		20,343			—			20,343
Property and equipment, net	—			25,643		2,002			—			27,645
Other assets	12,258			25,844		2,499			(14,718		)	25,883
Intercompany receivables	—			141		—			(141		)	—
Investment in consolidated subsidiaries	78,050			—		—			(78,050		)	—
	$	243,375		$	230,679	$	39,205		$	(92,931	)	$	420,328

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	—		$	958	$	—		$	—		$	958
Payable under securities loan agreement	124,619			—		—			—			124,619
Other current liabilities	5,466			41,179		3,689			(22		)	50,312
Liabilities of discontinued operations	—			18,566		—			—			18,566
Total current liabilities	130,085			60,703		3,689			(22		)	194,455
Long-term debt	120,000			2,000		—			—			122,000
Asbestos litigation liability	—			—		31,852			—			31,852
Other long-term liabilities	2,152			41,253		11,768			(14,718		)	40,455
Intercompany (receivables) payables	(40,428		)	40,528		41			(141		)	—
Shareholders’ equity (deficit)	31,566			86,195		(8,145		)	(78,050		)	31,566
	$	243,375		$	230,679	$	39,205		$	(92,931	)	$	420,328

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

Three Months Ended September 30, 2005

(Dollars in thousands)

(Unaudited)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)			Detroit Stoker Company (Non- Guarantor)			Eliminations			United Industrial Corporation and Subsidiaries

Net sales	$	—		$	116,815		$	9,587		$	—		$	126,402
Cost of sales	—			90,983			5,785			—			96,768
Gross profit	—			25,832			3,802			—			29,634
Selling and administrative expenses	—			11,994			2,324			—			14,318
Other operating income (expense) - net	16			(103		)	(193		)	—			(280		)
Total operating income	16			13,735			1,285			—			15,036
Non-operating income and (expense):
Interest income	510			156			64			—			730
Interest expense	(1,371		)	(52		)	(1		)	—			(1,424		)
Equity in net income of joint venture				114									114
Intercompany interest income (expense)	1			—			(1		)	—			—
Other income (expense) - net	78			(159		)	40			—			(41		)

	(782		)	59			102			—			(621		)
(Loss) income from continuing operations before income taxes	(766		)	13,794			1,387			—			14,415
Benefit from (provision for) income taxes	255			(4,891		)	(465		)	—			(5,101		)
(Loss) income from continuing operations	(511		)	8,903			922			—			9,314
Income from discontinued operations – net of income tax benefit	—			112			—			—			112
Income from investment in subsidiaries	9,937			—			—			(9,937		)	—
Net income (loss)	$	9,426		$	9,015		$	922		$	(9,937	)	$	9,426

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

Three Months Ended September 30, 2004

(Dollars in thousands)

(Unaudited)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)			Detroit Stoker Company (Non- Guarantor)			Eliminations			United Industrial Corporation and Subsidiaries

Net sales	$	—		$	90,143		$	8,576		$	—		$	98,719
Cost of sales	—			68,682			5,276			—			73,958
Gross profit	—			21,461			3,300			—			24,761
Selling and administrative expenses	—			10,492			2,156			—			12,648
Other operating income (expense)- net	25			(120		)	8			—			(87		)
Total operating income	25			10,849			1,152			—			12,026
Non-operating income and (expense):
Interest income	63			68			20			—			151
Interest expense	(235		)	(19		)	—			—			(254		)
Intercompany interest income (expense)	15			—			(15		)	—			—
Other income - net				59			28			—			87
	(157		)	108			33			—			(16		)
(Loss) income from continuing operations before income taxes	(132		)	10,957			1,185			—			12,010
Benefit from (provision for) income taxes	37			(3,852		)	(451		)	—			(4,266		)
(Loss) income from continuing operations	(95		)	7,105			734			—			7,744
Loss from discontinued operations – net of income tax benefit	—			(274		)	—			—			(274		)
Income from investment in subsidiaries	7,565			—			—			(7,565		)	—
Net income (loss)	$	7,470		$	6,831		$	734		$	(7,565	)	$	7,470

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

Nine Months Ended September 30, 2005

(Dollars in thousands)

(Unaudited)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)			Detroit Stoker Company (Non- Guarantor)			Eliminations			United Industrial Corporation and Subsidiaries

Net sales	$	—		$	328,586		$	25,292		$	—		$	353,878
Cost of sales	—			252,017			15,899			—			267,916
Gross profit	—			76,569			9,393			—			85,962
Selling and administrative expenses	—			38,555			6,713			—			45,268
Other operating income (expense), net	48			(460		)	(392		)	—			(804		)
Total operating income	48			37,554			2,288			—			39,890
Non-operating income and (expense):
Interest income	1,946			382			151			—			2,479
Interest expense	(4,479		)	(162		)	(1		)	—			(4,642		)
Intercompany interest income (expense)	4			—			(4		)	—			—
Other income, net	395			7,679			40			—			8,114
	(2,134		)	7,899			186			—			5,951
(Loss) income from continuing operations before income taxes	(2,086		)	45,453			2,474			—			45,841
Benefit from (provision for) income taxes	697			(15,466		)	(833		)	—			(15,602		)
(Loss) income from continuing operations	(1,389		)	29,987			1,641			—			30,239
Income from discontinued operations, net of income tax provision	—			305			—			—			305
Income from investment in subsidiaries	31,933			—			—			(31,933		)	—
Net income (loss)	$	30,544		$	30,292		$	1,641		$	(31,933	)	$	30,544

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

Nine Months Ended September 30, 2004

(Dollars in thousands)

(Unaudited)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)			Detroit Stoker Company (Non- Guarantor)			Eliminations			United Industrial Corporation and Subsidiaries

Net sales	$	—		$	266,510		$	23,417		$	—		$	289,927
Cost of sales	—			205,225			14,404			—			219,629
Gross profit	—			61,285			9,013			—			70,298
Selling and administrative expenses	—			28,326			6,520			—			34,846
Other operating income (expense), net	81			(376		)	22			—			(273		)
Total operating income	81			32,583			2,515			—			35,179
Non-operating income and (expense):
Interest income	63			170			48			—			281
Interest expense	(235		)	(45		)	—			—			(280		)
Intercompany interest (expense) income	(330		)	357			(27		)	—			—
Other (expense) income, net	(4		)	127			112			—			235
	(506		)	609			133			—			236
(Loss) income from continuing operations before income taxes	(425		)	33,192			2,648			—			35,415
Benefit from (provision for) income taxes	140			(11,752		)	(1,014		)	—			(12,626		)
(Loss) income from continuing operations	(285		)	21,440			1,634			—			22,789
Loss from discontinued operations, net of income tax benefit	—			(939		)	—			—			(939		)
Income from investment in subsidiaries	22,135			—			—			(22,135		)	—
Net income (loss)	$	21,850		$	20,501		$	1,634		$	(22,135	)	$	21,850

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2005

(Dollars in thousands)

(Unaudited)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)			Detroit Stoker Company (Non- Guarantor)			Eliminations		United Industrial Corporation and Subsidiaries

OPERATING ACTIVITIES:
Cash flows (used in) provided by continuing operations	$	(11,637	)	$	39,920		$	2,355		$	—	$	30,638
Cash flows used in discontinued operations	—			(3,418		)	—			—		(3,418		)
Net cash (used in) provided by operating activities	(11,637		)	36,502			2,355			—		27,220
INVESTING ACTIVITIES:
Purchase of property and equipment	—			(18,185		)	(93		)	—		(18,278		)
Proceeds from sale of available-for-sale securities	124,626			—			—			—		124,626
Investments in marketable equity securities	(12,780		)	—			—					(12,780		)
Business acquisition, net of cash acquired	—			(9,883		)	—			—		(9,883		)
Proceeds from sale of property	—			7,555			—			—		7,555
Net cash provided by (used in) investing activities	111,846			(20,513		)	(93		)			91,240
FINANCING ACTIVITIES:
Repayment of collateral received from securities lending transaction	(124,619		)	—			—			—		(124,619		)
Repayment of long-term debt	—			(947		)	—			—		(947		)
Proceeds from exercise of stock options	1,474			—			—			—		1,474
Dividends paid	(3,705		)	—			—			—		(3,705		)
Decrease in restricted cash	25,000			4,033			—			—		29,033
Purchase of treasury shares	(34,225		)	—			—			—		(34,225		)
Intercompany	88,072			(88,072		)	—			—		—
Net cash (used in) provided by financing activities	(48,003		)	(84,986		)	—			—		(132,989		)
Increase (decrease) in cash and cash equivalents	52,206			(68,997		)	2,262			—		(14,529		)
Cash and cash equivalents at beginning of year	129			72,269			8,281			—		80,679
Cash and cash equivalents at end of period	$	52,335		$	3,272		$	10,543		$	—	$	66,150

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2004

(Dollars in the thousands)

(Unaudited)

	United Industrial Corporation (Parent)			AAI Corporation and Subsidiaries (Guarantor)			Detroit Stoker Company (Non- Guarantor)			Eliminations		United Industrial Corporation and Subsidiaries

OPERATING ACTIVITIES:
Cash flows provided by (used in) continuing operations	$	2,976		$	653		$	1,288		$	—	$	4,917
Cash flows used in discontinued operations	—			(4,051		)	—			—		(4,051		)
Net cash provided by (used in) operating activities	2,976			(3,398		)	1,288			—		866
INVESTING ACTIVITIES:
Purchase of property and equipment	—			(2,661		)	(203		)	—		(2,864		)
Net cash used in investing activities	—			(2,661		)	(203		)	—		(2,864		)
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt	120,000			—			—			—		120,000
Debt issuance fees paid	(3,600		)	—			—			—		(3,600		)
Repayment of long-term debt	—			(668		)	—			—		(668		)
Proceeds from exercise of stock options	3,352			—			—			—		3,352
Dividends paid	(3,881		)	—			—			—		(3,881		)
Purchase of treasury shares	(34,842		)	—			—			—		(34,842		)
Intercompany	(84,348		)	82,740			1,608			—		—
Net cash (used in) provided by financing activities	(3,319		)	82,072			1,608			—		80,361
(Decrease) increase in cash and cash equivalents	(343		)	76,013			2,693			—		78,363
Cash and cash equivalents at beginning of year	648			17,482			6,008			—		24,138
Cash and cash equivalents at end of period	$	305		$	93,495		$	8,701		$	—	$	102,501

Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on management’s expectations, estimates, projections and assumptions. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” and variations of such words and similar expressions are intended to identify such forward-looking statements which include, but are not limited to, projections of revenues, earnings, segment performance, cash flows and contract awards. These forward-looking statements are subject to risks and uncertainties, which could cause the actual results or performance of United Industrial Corporation and its subsidiaries (collectively, the “Company”) to differ materially from those expressed or implied in such statements. These risks and uncertainties include, but are not limited to, the following:

• the Company’s successful execution of internal performance plans;

• performance issues with key suppliers, subcontractors and business partners;

• the ability to negotiate financing arrangements with lenders;

• the outcome of current and future litigation, proceedings and investigations;

• the accuracy of the Company’s analysis of its potential asbestos-related exposure and insurance coverage;

• product demand and market acceptance risks;

• the effect of economic conditions;

• the impact of competitive products and pricing;

• product development, commercialization and technological difficulties;

• capacity and supply constraints or difficulties;

• the integration of acquisitions;

• legislative or regulatory actions impacting the Company’s Defense segment, Energy segment and discontinued transportation operation;

• changing priorities or reductions in the U.S. Government’s defense budget;

• contract continuation and future contract awards; and

• U.S. and foreign military budget constraints and determinations.

The Company intends that all forward-looking statements it makes will be subject to the safe harbor protection of the Federal securities laws found in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

These statements speak only as to the date when they are made. The Company makes no commitment to update any forward-looking statement or to disclose any facts, events, or circumstances after the date hereof that may affect the accuracy of any forward-looking statements. See “Risk Factors” under Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, for important factors that could cause the Company’s actual results to differ materially from those suggested by the Company’s forward-looking statements contained in this Quarterly Report on Form 10-Q.

The Company designs, develops, manufactures and supports defense systems and training and test systems. The Company is committed to creating innovative solutions, disciplined program management and continuous operational improvements. Its products and services include unmanned aerial vehicle (“UAV”) systems, training and simulation systems, automated aircraft test and maintenance equipment, armament systems, logistical and engineering services, and other leading-edge technology solutions for defense needs. The Company also manufactures combustion equipment for biomass and refuse fuels.

Overview of Consolidated Results

	Three Months Ended September 30,						Increase (Decrease)				Nine Months Ended September 30,				Increase (Decrease)
(Dollars in thousands)	2005			2004			$		%		2005		2004		$		%

Net sales	$	126,402		$	98,719		$	27,683	28.0	%	$	353,878	$	289,927	$	63,951	22.1	%
Gross profit	29,634			24,761			4,873		19.7	%	85,962		70,298		15,664		22.3	%
Selling and administrative expenses	14,318			12,648			1,670		13.2	%	45,268		34,846		10,422		29.9	%
Operating income	15,036			12,026			3,010		25.0	%	39,890		35,179		4,711		13.4	%
Non-operating income (expense)	(621		)	(16		)	605		3781.3	%	5,951		236		5,715		2421.6	%
Income from continuing operations, net of income taxes	9,314			7,744			1,570		20.3	%	30,329		22,789		7,450		32.7	%

Defense Segment

	Three Months Ended September 30,				Increase (Decrease)				Nine Months Ended September 30,				Increase (Decrease)
(Dollars in thousands)	2005		2004		$		%		2005		2004		$		%

Net sales	$	116,815	$	90,143	$	26,672	29.6	%	$	328,586	$	266,510	$	62,076	23.3	%
Gross profit	25,832		21,461		4,371		20.4	%	76,569		61,285		15,284		24.9	%
Selling and administrative expenses	11,994		10,492		1,502		14.3	%	38,555		28,326		10,229		36.1	%
Operating income	13,735		10,849		2,886		26.6	%	37,554		32,583		4,971		15.3	%
Income before income taxes	13,794		10,957		2,837		25.9	%	45,453		33,192		12,261		36.9	%

Energy Segment

	Three Months Ended September 30,				Increase (Decrease)				Nine Months Ended September 30,				Increase (Decrease)
(Dollars in thousands)	2005		2004		$		%		2005		2004		$			%

Net sales	$	9,587	$	8,576	$	1,011	11.8	%	$	25,292	$	23,417	$	1,875		8.0	%
Gross profit	3,802		3,300		502		15.2	%	9,393		9,013		380			4.2	%
Selling and administrative expenses	2,324		2,156		168		7.8	%	6,713		6,520		193			3.0	%
Income before income taxes	1,388		1,185		203		17.1	%	2,478		2,648		(170		)	(6.4	)%

Three Months Ended September 30, 2005 compared to the Three Months Ended September 30, 2004

The Company’s net sales increased 28.0% for the three months ended September 30, 2005 compared to the three months ended September 30, 2004, including $26,672,000 and $1,011,000 higher net sales for the Defense and Energy segments, respectively. Net sales for the Defense segment for the three months ended September 30, 2005 increased 29.6% to $116,815,000 from $90,143,000 for the three months ended September 30, 2004. The increase was primarily due to greater logistical support related to an increasing number of fielded Shadow 200 TUAV Systems in 2005, growth in the volume of ABE Systems, the Biological Detection Systems program awarded in the third quarter of 2004 and the acquisition of ESL in the second quarter of 2005.

The gross margin percentage for continuing operations decreased to 23.4% in the third quarter of 2005 from 25.1% during the same period in 2004. The Defense segment’s gross margin percentage was 22.1% in the third quarter 2005 compared to 23.8% during the same period in 2004. Increased sales generated by increased Shadow 200 TUAV logistical support and Services’ business, that generate lower gross margin percentages than other sales realized by AAI, primarily caused the decreased margin.

Selling and administrative expense increased to $14,318,000, in the third quarter of 2005 compared to $12,648,000 during the same period in 2004. However, as a percentage of sales, selling and administrative expenses decreased to 11.3% in the third quarter of 2005 compared to 12.8% during the same period in 2004. Selling and administrative expense in the Defense segment increased to $11,994,000, or 10.3% of sales, in the third quarter of 2005 from $10,492,000, or 11.6% of sales, during the same period in 2004. The $1,502,000 increase was primarily due to $1,273,000 higher research and development expense and bid and proposal costs to support the Defense segment’s growth, $1,062,000 of general and administrative expenses incurred by the recently acquired ESL, $620,000 of increased legal expenses, partially offset by expense reductions of $1,453,000 in lower costs mostly related to the reorganization of the Defense segment’s fluid test system product area.

Operating income for the Company increased to $15,036,000, or 11.9% of sales, in the third quarter of 2005 from $12,026,000, or 12.2% of sales, during the same period in 2004. Operating income in the Defense segment increased to $13,735,000, or 11.8% of sales, in the third quarter of 2005 from $10,849,000, or 12.0% of sales, during the same period in 2004. The decrease in operating income as a percentage of sales is primarily due to the decrease in the gross profit percentage.

Net interest expense increased $591,000 to $694,000 in the third quarter of 2005 from net interest expense of $103,000 during the same period in 2004 primarily as a result of the payment of interest to the holders of the Company’s $120,000,000 3.75% Convertible Senior Notes issued in September 2004.

Net income from continuing operations net of income taxes in the third quarter of 2005 increased to $9,314,000, or $0.68 per diluted share, compared to $7,744,000, or $0.57 per diluted share, during the same period in 2004.

Net income that includes the results of both continuing and discontinued operations in the third quarter of 2005 increased to $9,426,000, or $0.69 per diluted share, compared to $7,470,000, or $0.55 per diluted share, during the same period in 2004.

Nine Months Ended September 30, 2005 compared to the Nine Months Ended September 30, 2004

Net sales from continuing operations for the nine months ended September 30, 2005 increased 22.1% to $353,878,000 compared to $289,927,000 for the nine months ended September 30, 2004. Net sales for the Defense segment for the nine months ended September 30, 2005 increased 23.3% to $328,586,000 from $266,510,000 for the nine months ended September 30, 2004. The increase was primarily due to higher production and logistical support related to an increasing number of fielded Shadow 200 TUAV Systems in 2005, increased demand for ABE Systems, the Biological Detection System Program that was awarded in the third quarter of 2004, and the acquisition of ESL in the second quarter of 2005.

The gross margin percentage for continuing operations increased to 24.3% in the nine months ended September 30, 2005 from 24.2% during the same period in 2004. The gross margin percentage for the Defense segment increased to 23.3% in the nine months ended September 30, 2005 from 23.0% in the nine months ended September 30, 2004.

Selling and administrative expenses in the nine months ended September 30, 2005 increased to $45,268,000, or 12.8% of sales, from $34,846,000, or 12.0% of sales, during the same period in 2004. Selling and administrative expenses in the Defense segment in the nine months ended September 30, 2005 increased to $38,555,000 or 11.7% of sales, from $28,326,000, or 10.6% of sales, during the same period in 2004. The $10,299,000 increase was primarily due to $4,671,000 for higher research and development expenses and bid and proposal costs to support the Defense segment’s growth, $1,928,000 of restructuring charges to reorganize the Defense segment’s fluid test systems product area, $1,748,000 of general and administrative expenses incurred by the recently acquired ESL, $1,400,000 of higher legal expenses, and other expenses reduction of $552,000.

Operating income increased to $39,890,000, or 11.3% of sales, in the nine months ended September 30, 2005 from $35,179,000, or 12.1% of sales, during the same period in 2004. Operating income in the Defense segment increased to $37,544,000, or 11.4% of sales, in the nine months ended September 30, 2005, from $32,583,000, or 12.2% of sales, during the same period in 2004.

Net interest expense was $2,163,000 for the nine months ended September 30, 2005 an increase of $2,162,000 from the nine months ended September 30, 2004 primarily as a result of the payment of interest to the holders of the Company’s $120,000,000 3.75% Convertible Senior Notes issued in September 2004. Included in the interest expense for 2005 is approximately $4,100,000 related to the $120,000,000 3.75% Convertible Senior Notes issued in September 2004.

Income from continuing operations before income taxes increased 29.4%, to $45,841,000 in the nine months ended September 30, 2005 from $35,415,000 during the same period in 2004. This increase included a $7,152,000 gain from the sale of undeveloped property recorded during the first quarter of 2005.

Net income from continuing operations, net of taxes in the nine months ended September 30, 2005 increased $7,450,000 to $30,239,000, or $2.13 per diluted share, compared to $22,789,000, or $1.70 per diluted share, during the same period in 2004.

Net income that includes the results of both continuing and discontinued operations in the nine months ended September 30, 2005 increased to $30,544,000, or $2.15 per diluted share, compared to $21,850,000, or $1.63 per diluted share, during the same period in 2004.

Discontinued Transportation Operations

Income from the Company’s discontinued transportation operations for the third quarter of 2005 was $112,000, or $0.01 per diluted share, compared to a loss of ($274,000), or ($0.02) per diluted share during the same period in 2004.

Income from the Company’s discontinued transportation operations for the nine months ended September 30, 2005 was $305,000, or $0.02 per diluted share, as compared to a loss of ($939,000), or ($0.07) per diluted share, during the same period in 2004.

Electric Transit, Inc. (“ETI”), an entity owned 35% by AAI and 65% by Skoda a.s. (“Skoda”), a Czech company, sold its remaining inventory of spare parts and continued to favorably resolve certain operational challenges associated with its last remaining program during the nine months ended September 30, 2005, which contributed to the favorable results from the discontinued transportation operations in 2005.

For additional information regarding the discontinued transportation operations, see Note M to the Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q.

Funded Backlog

(Dollars in thousands)	September 30, 2005		December 31, 2004
Defense segment	$	508,633	$	380,622
Energy segment	11,230		7,296
Total	$	519,863	$	387,918

The Company’s funded backlog for continuing operations, defined as orders placed for which funds have been appropriated or purchase orders received, was $519,863,000 at September 30, 2005, an increase of $131,945,000, or 34.0%, from December 31, 2004.

The Company received $163,618,000 of funded new orders for products and services during the third quarter of 2005, an increase of $38,812,000, or 31.1%, compared to $124,806,000 the third quarter of 2004. Included in the third quarter 2005 were funded new orders of $153,128,000 in the Defense segment and $10,490,000 in the Energy segment.

For the nine months ended September 30, 2005, the Company received $484,009,000 in funded new orders compared to $297,360,000 for the nine months ended September 30, 2004, an increase of $186,649,000, or 62.8%. The funded new orders for the nine months ended September 30, 2005 included $453,977,000 of funded new orders in the Defense segment and $30,032,000 of funded new orders in the Energy segment.

The increase in the funded backlog for the Defense segment included additional funding for existing contracts and funding for new contracts, for new Shadow 200 TUAV systems, logistical support for fielded Shadow 200 TUAV systems and development of ground control stations. Further, we received additional funding for the Biological Detection Systems program.

The increase in the Energy segment’s funded backlog was primarily due to an increase in orders received during the third quarter of 2005.

Liquidity and Capital Resources

Overview

The Company’s principal source of liquidity is cash on hand and cash generated from operations. On September 30, 2005, the Company had cash and cash equivalents of $66,150,000. Effective December 23, 2004, the Company terminated its Loan and Security Agreement dated June 28, 2001, as amended, with Bank of America Business Capital (formerly Fleet Capital Corporation). On July 18, 2005, the Company and AAI, entered into a $100,000,000 four-year revolving Credit Agreement with a syndicate of six banks, consisting of SunTrust Bank, as administrative agent and issuing bank, Citibank, F.S.B., Key Bank, PNC Bank, Commerce Bank and Provident Bank. The Credit Agreement provides for a Credit Facility consisting of a $100,000,000 Senior Secured Revolving Credit Facility with a $5,000,000 Swing Line and a $100,000,000 Letter of Credit sub-facility. The interest rate for loans made under this facility is thirty-day LIBOR plus an applicable margin between 1.25% and 2.00% based upon the Company’s leverage ratio. As of September 30, 2005, the Company had $2,939,000 outstanding under the Letter of Credit sub-facility. Pursuant to the terms of the Credit Agreement and the Parent Guaranty, the Company has guarantied AAI’s obligations. The proceeds of the Credit Facility will be used to fund future acquisitions, finance capital expenditures, provide working capital, fund letters of credit, and for other general corporate purposes. Based on cash on hand, future cash expected to be generated from operations, and the new Credit Facility, the Company expects to have sufficient cash to meet its requirements for at least the next twelve months.

On December 29, 2004, the Company invested $124,619,000 in U.S. treasury bills maturing on February 24, 2005. The U.S. treasury bills were concurrently loaned to the Company’s broker-dealer in a securities lending transaction in exchange for cash collateral in an amount equal to 100% of the fair value of the securities lent. The securities lending transaction terminated on February 23, 2005, at which time the Company redeemed the U.S. treasury bills and received approximately $373,000 of interest thereon, repaid the cash collateral to its broker-dealer together with $444,000 of related interest charges, and collected the $25,000,000 deposit plus $86,000 of accrued interest thereon.

As discussed under the subheading “Gain on Sale of Property” in the “Management Overview” section above, in January 2005, the Company sold approximately 26 acres of undeveloped property adjacent to its Hunt Valley, Maryland facility for $8,105,000, which yielded proceeds of $7,555,000, net of selling expenses and closing costs. The Company reinvested approximately $5,085,000 of the net proceeds from this sale in a new facility in South Carolina for AAI Services to support the growth in their operations. The remaining net proceeds were disbursed from a qualified intermediary account by July 11, 2005, and were used primarily for improvements to the facility. As a result, the Company expects that it will be able to defer paying substantially all of the income tax obligation incurred in connection with the gain on the sale of the property in Hunt Valley, in accordance with Section 1031 (b) of the Internal Revenue Code.

In accordance with its strategic initiatives to enhance shareholder value, the Company is continuing to focus its efforts on the profitability and growth of its core Defense product areas, seeking to maximize operating efficiencies, and exploring the sale of non-core assets.

The Company intends to complement its growth strategy for its Defense segment through select acquisitions that broaden its product and service offerings, deepen its capabilities, and allow entry into new markets. Acquisition candidates may include public and private companies and divisions, subsidiaries and product lines of such companies. In accordance with this initiative on April 4, 2005, the Company acquired ESL, an electronic warfare systems company based in the United Kingdom, as more fully discussed in the “Management Overview” section above.

During the fourth quarter of 2003, as part of the Company’s strategy to explore the sale of non-core assets, the Company engaged Imperial Capital, LLC, an investment-banking firm, to act as exclusive financial advisor to assist in exploring strategic alternatives for Detroit Stoker, including a possible sale (the “Transaction”). The Company and Imperial Capital are continuing to explore potential Transactions involving Detroit Stoker. From time to time, the Company and potential buyers may (i) have discussions regarding a potential Transaction, (ii) negotiate the preliminary terms of a potential Transaction, and (iii) enter into customary non-binding agreements in order to facilitate any such discussions and negotiations. No assurances can be given regarding whether a Transaction involving Detroit Stoker will occur or the timing or proceeds from any such Transaction.

Sources and Uses of Cash

The following is a discussion of the Company’s major operating, investing, and financing activities for each of the nine-month periods ended September 30, 2005 and 2004. The financial information presented in the table below is summarized from the Company’s Consolidated Condensed Statements of Cash Flows.

	Nine Months Ended September 30,
(Dollars in thousands)	2005			2004
Operating activities:
Net cash provided by continuing operations	$	30,638		$	4,917
Net cash used in discontinued operations	(3,418		)	(4,051		)
Net cash provided by operating activities	27,220			866
Net cash provided by (used in) investing activities	91,240			(2,864		)
Net cash (used in) provided by financing activities	(132,989		)	80,361
(Decrease) increase in cash and cash equivalents	$	(14,529	)	$	78,363

Operating Activities

Net cash provided by continuing operations in the nine months ended September 30, 2005 increased $25,721,000 to $30,638,000 compared to $4,917,000 for the nine months ended September 30, 2004 due to a decrease of $20,776,000 in cash used in operations for changes in operating assets and liabilities and an increase in cash provided of $4,945,000 due to higher income from continuing operations before non-cash depreciation and other charges. Cash provided by income from continuing operations before non-cash depreciation and other charges was $35,533,000 for the nine months ended September 30, 2005. Changes in operating assets and liabilities in the nine months ended September 30, 2005 used cash of $4,895,000, which included an increase in accounts receivable of $11,930,000 due to the timing of milestone invoicing and payments, offset by a decrease in inventory of $2,247,000, a decrease in prepaid expenses and other current assets of $2,638,000 and a net increase in other operating liabilities of $2,150,000. Cash provided by income from continuing operations before non-cash depreciation and other charges was $30,588,000 for the nine months ended September 30, 2004. Changes in operating assets and liabilities in the nine months ended September 30, 2004 used cash of $25,671,000 which included an increase in accounts receivable of $22,030,000 due to significant billings at the end of the quarter, an increase in inventory of $19,501,000 due to higher production levels as well as temporary deferral in certain billing milestones, and an increase in prepaid expenses and other current assets of $616,000, offset by increases in operating liabilities of $16,476,000. Inventory was lower and accounts receivable higher at September 30, 2005 than at September 30, 2004 primarily due to the achievement of certain billing milestones in the Defense segment.

The Company’s cash flows from operations are dependent on the timing of receipts from various government payment offices and, as a result, may differ from period to period and such differences could be significant.

Net cash used by the discontinued transportation operations in the nine months ended September 30, 2005 primarily related to unreimbursed services and other financial support provided to ETI in connection with the MUNI contract guaranty agreement as discussed in Note N.

Investing Activities

On December 29, 2004, the Company invested $124,619,000 of cash in U.S. treasury bills, which matured on February 24, 2005. The U.S. treasury bills were concurrently loaned to the Company’s broker-dealer in a securities lending transaction, which is discussed in the “Liquidity Overview” section above.

During the nine months ended September 30, 2005, the Company invested $12,780,000 in marketable common stock securities that are available for sale.

Cash used for the purchase of property and equipment was $18,278,000, including $7,470,000 for the purchase and improvement of a building in South Carolina, $3,616,000 for implementation of AAI’s new Enterprise Resource Planning (“ERP”) system, and $4,990,000 for Defense facility improvements including $2,016,000 for enhancements to the UAV Production Facilities for the nine months ended September 30, 2005. Capital expenditures were $2,864,000 for the same period of the prior year and was the only investing activity for the nine months ended September 30, 2004. The Company anticipates that future requirements for expenditures will include completing the facilities improvement and the ERP system implementation as well as expenditures incurred during the ordinary course of business. See “Capital Expenditures” below.

On April 4, 2005, the Company purchased ESL for $9,883,000, net of cash acquired.

Net cash provided by investing activities in 2005 included proceeds of $7,555,000 from the sale of certain undeveloped property at the Company’s Hunt Valley, MD corporate headquarters.

Financing Activities

The Company’s financing activities for the nine months ended September 30, 2005 used $132,989,000 of cash, including approximately $124,619,000 for the repayment of collateral received from a securities lending transaction of U.S. treasury bills that were sold concurrently. In connection with this securities lending transaction, which is discussed more fully in the “Liquidity Overview” section above, the Company also received the $25,000,000 refundable deposit from its broker-dealer.

This deposit, together with a decrease of $4,033,000 in collateral the Company was required to post in connection with outstanding letters of credit and a cash management security arrangement with Bank of America Business Capital, is presented as a $29,033,000 decrease in restricted cash in the accompanying Consolidated Statements of Cash Flows for the period ending September 30, 2005.

Financing activities in 2005 also included $34,225,000 for the purchase of the Company’s common stock, $3,705,000 of cash used for the payment of dividends, $1,474,000 of cash receipts from the exercise of stock options, and $947,000 used for the repayment of long-term debt, primarily related to the financing of the ERP System.

Net cash provided by the Company’s financing activities for the nine months ended September 30, 2004 was $80,361,000, including approximately $92,044,000 of net proceeds from the issuance and sale of the 3.75% Convertible Senior Notes after the concurrent repurchase of 850,400 shares of Common Stock for $24,356,000 and deducting $3,600,000 of investment banking fees associated with the sale. Financing activities also include $3,352,000 of cash receipts from the exercise of stock options, partially offset by $10,486,000 of cash used for the repurchase of the Company’s Common Stock under its previously announced repurchase programs, $3,881,000 of cash used for the payment of dividends, and $668,000 used for the repayment of long-term debt related to the financing of AAI’s new ERP System.

Debt and Related Covenants

The Credit Facility entered into on July 18, 2005 by the Company and AAI contains affirmative, negative and financial covenants customary for facilities of this type, including, among other things, maintenance of certain leverage and fixed charge coverage ratios, as well as minimum consolidated tangible net worth ratios, limits on the incurrence of debt and preferred equity, limits on the incurrence of liens, a limit on the making of dividends or distributions, limits on sales of assets and a limit on capital expenditures.

For a complete description of the Company’s long-term debt, including the terms and conditions of each debt instrument, please see Note 6 to the Consolidated Financial Statements included in Part II, Item 8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and Note G to the Consolidated Condensed Financial Statements included in part I, Item 1 of this Quarterly Report on Form 10-Q. There are no covenant violations as of September 30, 2005.

Cash Requirements

Capital Expenditures

The Company expects that capital expenditures in 2005 will be significantly higher than in 2004 primarily due to (i) the purchase of the $5,085,000 new facility in South Carolina, and approximately $3,500,000 of improvements to be made to that facility, (ii) approximately $3,200,000 of enhancements to the Company’s UAV production facilities, including the purchase of new manufacturing equipment to increase production output and efficiency and (iii) $4,800,000 related to the continuing implementation of the Company’s ERP System.

As of September 30, 2005, the Company had no significant commitments for capital expenditures except for the continuing implementation of its new ERP System. The Company expects to incur approximately $2,000,000 related to the implementation of its ERP System, which exclude ongoing annual maintenance fees of approximately $400,000 per year. As of September 30, 2005, the Company had capitalized a total of approximately $6,920,000 related to the implementation of the ERP System, $2,385,000 for improvements to the new facility in South Carolina and $2,016,000 for enhancements to the Company’s UAV production facilities as well as $2,974,000 in general facility improvements for the year.

Other Cash Requirements

PART II - OTHER INFORMATION

Reference is made to the information contained in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth above in Item 2 of Part I and to Note N to the Consolidated Condensed Financial Statements included herein, which information is incorporated herein by reference.

Item 2. – Unregistered Sales of Equity Securities and Use of Proceeds

For information regarding the Company’s purchases of its equity securities, please reference Note P to the Consolidated Condensed Financial Statements included herein, which information is incorporated herein by reference.

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as a Part of Publicly Announced Programs	Approximate Dollar Value of Shares That May Yet Be Purchased Under The Program
					(in millions)
7/1/05 – 7/31/05	—	—		—	$	—
8/1/05 – 8/31/05	—	—		—	$	—
9/1/05 – 9/30/05	262,578	$	35.22	262,578	$	5.7

Item 6. - Exhibits

31.1 Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer of the Company.

31.2 Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer of the Company.

32.1 Section 1350 Certification by the Chief Executive Officer of the Company.

32.2 Section 1350 Certification by the Chief Financial Officer of the Company.

		Page
PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

	Consolidated Condensed Balance Sheets - September 30, 2005 and December 31, 2004	2

	Consolidated Condensed Statements of Operations - Three Months and Nine Months Ended September 30, 2005 and 2004	3

	Consolidated Condensed Statements of Cash Flows - Nine Months Ended September 30, 2005 and 2004	4

	Notes to Consolidated Condensed Financial Statements	5

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		29

Item 3. Quantitative and Qualitative Disclosures About Market Risk		41

Item 4. Controls and Procedures		41

PART II - OTHER INFORMATION

Item 1. Legal Proceedings		42

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		42

Item 6. Exhibits		42

SIGNATURES		43

Exhibit No.

31.1		Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer of the Company.

31.2		Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of the Company.

32.1		Section 1350 Certification of the Chief Executive Officer of the Company.

32.2		Section 1350 Certification of the Chief Financial Officer of the Company.

UNITED INDUSTRIAL CORPORATION

November 8, 2005

/s/ James H. Perry

James H. Perry
Vice President, and
Chief Financial Officer
(as duly authorized officer
and principal accounting
officer)